John R. Graham is a financial, economic, and policy analyst in the health sector. His appointments include:
Senior Fellow of The National Center for Policy Analysis;
Senior Fellow of The Independent Institute;
Senior Fellow of the Pacific Research Institute;
Senior Fellow of The Fraser Institute;
Adjunct Scholar of The Mackinac Center for Public Policy;
Columnist at Forbes.com's The Apothecary blog;
Member of the Board of Visitors of The Benjamin Rush Society of medical students and physicians.

Eight state governors have stated that they will take advantage of the recent Supreme Court ruling, allowing them to opt out of Obamacare’s dramatic expansion of Medicaid. Their actions have been dismissed by liberal columnists as mere partisan posturing. After all, argue the liberals, the federal government is picking up most of the tab, so what’s the problem? Don’t governors have every incentive to fleece the taxpayers of other states? It turns out, however, that this logic is flawed, and that the Medicaid expansion will cause state budgets to explode. Here’s why.

Prior to Obamcare, the Medicaid program was somewhat limited. All states who have signed up for the program (which, today, is all of them) are required to cover pregnant women and children younger than 6 with family income under 133 percent of the federal poverty level, and children aged 6-18 with family income under 100 percent of FPL. There are other eligible populations, such as people with disabilities, certain low-income parents, and low-income Medicare beneficiaries.

How federal and state governments share Medicaid’s costs

The federal government provides matching funds to states, to help them fund their Medicaid programs, using a formula called the Federal Medical Assistance Percentage, or FMAP. On average, Washington will spend $57 for every $43 that states spend on Medicaid. Over time, this has led many states—like New York—to substantially expand their Medicaid programs, because for every dollar they spend expanding Medicaid for their residents, taxpayers in other states are on the hook for an extra $1.33.

Obamacare takes these incentives to their logical conclusion. Under Obamacare, starting in 2014, everyone with income below 133 percent of FPL will be eligible for Medicaid. For the first three years of the expansion, federal taxpayers will pick up the full cost of the expansion. This 100 percent funding rate will phase down to 95 percent in 2017, 94 percent in 2018, 93 percent in 2019, and 90 percent in 2020.

Many states are rightly worried that, given federal budget pressures, Washington won’t continue to cover 90 percent of the costs after 2020. But because the new Medicaid enrollees will now be dependent on the government, states won’t be politically or legally able to roll back their programs, leaving state taxpayers with the bill. The Wall Street Journalaptly compares this to “a subprime loan with a teaser rate and balloon payment.”

“Folks don’t really understand the struggle states are in,” notes Dennis Smith, secretary of the Wisconsin Department of Health Services, who ran the federal Medicaid program under George W. Bush, in an interview with Julie Rovner. “States just don’t have the dollars, even with those enhanced federal match rates.”

Medicaid “woodwork” is a hidden time bomb

But an even bigger problem for states is what’s being called the “woodwork effect.” Harvard’s Ben Sommers and Arnold Epstein, in a 2010 article for the New England Journal of Medicine, estimated that only 62 percent of people who are eligible for Medicaid today have actually signed up for the program. As the below chart shows, participation rates are below 50 percent in large southern states like Florida (44 percent) and Texas (48 percent).

Here’s the kicker: this “woodwork” population, that was already eligible for Medicaid but not enrolled, won’t get the Obamacare 90-100 percent funding rate. Their expenses will be covered under the traditional FMAP percentage, meaning that states will be on the hook for 43 percent of the costs.

Nationally, Sommers and Epstein estimate that more than 9 million uninsured Americans were already eligible for Medicaid, pre-Obamacare, while failing to enroll. “Although only a portion of these people are likely to enroll in Medicaid” now that the program has been expanded, “adding them to the program’s rolls would nonetheless cost states billions of dollars in increased spending. Most affected would be states that currently have generous eligibility criteria for Medicaid, lower participation rates, a higher prevalence of low-income uninsured residents, or some combination of these factors.”

It’s not just red states like Texas that face this woodwork problem. New York’s generous eligibility criteria, combined with a substantial woodwork population, means that the Empire State faces substantial additional costs if these unenrolled individuals sign up for benefits. And New York is one of the states that has been most supportive of Obamacare’s coverage expansion.

These woodworkers will find it much easier to sign up for Medicaid under the program’s new rules. “It won’t be an in-person visit, it won’t be a ‘bring six forms of ID,’” University of Virginia’s Jeff Goldsmith told Rovner. “There will be an expedited—lubricated, if you will—process to get people onto the rolls, and I think that’s the part that’s giving state budget officers serious indigestion at this point.”

Look before your governor leaps

The bottom line is that states—and taxpayers in those states—need to keep a close eye on this woodwork problem, and understand how much it would cost them if these unenrolled Medicaid-eligible patients sign up. As P.J. O’Rourke memorably put it, “If you think health care is expensive now, wait until you see what it costs when it’s free.”

UPDATE: Josh Barro argues that the woodwork problem is “simply…not that large,” and that “expanded participation [in Medicaid] is a good thing.” He adds this curious observation regarding political economy: “If state governments become politically unable to drop expanded Medicaid, it will only be because the state’s residents consider the program a good use of taxpayer money. That hardly seems like a big risk.”

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This post is a complete falsehood. As more people are added to the risk pool, costs are spread across the whole.

So yes, cost will rise in the short term as more people who have never had access to the system are added. That was inevitable and often occurs in the private sector as well. However, as those people will not be accessing as many services over time, costs will begin to fall after about an 18 month period as the risk pool stabilizes.

Further, since the Medicaid programs will probably be farmed out to MC plans who will be incentivied to manage costs by collaborating with providers, getting people in for their preventive care and managing diseases and care, costs will also drop at that point. Again, this will occur 12-18 months into the full application of ACA.

Medicaid will primarily cover individuals, families & children up to 133% of FPL (approx 24-30M people). The exchanges will primarily cover the working poor, low wage workers and workers in small businesses that opt not to buy commercial coverage starting from 133% of FPL up to about 400% of FPL (approx 15-20M people). Above 400% of FPL are people in employer sponsored insurance.

The largest expenditure in Medicaid today are the ABD (Aged/Blind/Disabled) and SSI (Supplemental Security Income) folks and kids in foster care. As states turn those populations over to managed care programs THEY ACTUALLY SAVE MONEY AND CONTROL COSTS.

Additionally, there is a spike in the rate of people receiving Medicaid that corresponds withe the spike in th unemployment rate. As the rate comes down, so does the strain on the Medicaid system. The difference in 2014 will be there is a landing place for all people, particularly the lower wage workers that may have gone without coverage. This will also take the strain off of states for uncompensated care which will also ease the financial burden of taxpayers.

So while there are start-up costs involved (similiar to when the Medicare & Medicaid programs started) there is long term savings to having a healthier population with accessibility to affordable coverage.

States will opt-in, the federal government and congress will figure out the appropriate allocation and all citizens will pay a little more for the security of it all.

Avik_ Its OK to be partisan, But I have come to expect much more from you. You have a great mind, except when you get hung up like this in dogma instead of facts. Intellectually, this article is beneath you.

The system is broken, its going to stay broken, and it’s going to be even further broken. And 50 years from now, some new guy with equally ambiguous comments will be criticizing the exact same system you are defending now as needing “reform” – under the exact same set of appeals you are using now.

Just like it worked out under the last bunch of reforms laid out 40-50 years ago.

in 1993 the republicans said healthcare was broken and did NOTHING.nada,zippo,but scratch ass and USE their health care paid by OUR taxes. the liberal heritage’ foundation came up with a plan to counter clinton single payer it was,(drum roll) MANDATES.omg a right wing idea.romney of course had HIS version of obama care and the taxes used to pay for (drum roll) came from MCCAIN.yes boys and girls the whole thing is full of right wing ideas.which of course they are against cause a DEMOCRAT proposed them. tell you what come up with a BETTER solution.the right has had 20 years to think of one,and have yet to offer ANY alternatives.the time of running mouth and giving lip service is OVER.put up or shut up.

I can’t say I’m particularly sympathetic about the “woodwork problem” when states like Texas and Florida haven’t tried that hard to help eligible people enroll in Medicaid. I’m sorry, but having 25% of the population uninsured, as Texas does, is a travesty. I’m sure if the vast majority of the uninsured were white, this situation would probably not exist. But hey, they don’t have any income taxes, so clearly everything is hunky-dory in Texas. I suppose they could raise them slightly to pay for the Medicaid expansion if they can’t afford it otherwise, but I’m sure the job creators wouldn’t be so happy.

lemonjello-Well said Gordon Gekko: The richest one percent of this country owns half our country’s wealth, five trillion dollars. One third of that comes from hard work, two thirds comes from inheritance, interest on interest accumulating to widows and idiot sons and what I do, stock and real estate speculation. It’s bullshit. You got ninety percent of the American public out there with little or no net worth. I create nothing. I own. We make the rules, pal. The news, war, peace, famine, upheaval, the price per paper clip. We pick that rabbit out of the hat while everybody sits out there wondering how the hell we did it. Now you’re not naive enough to think we’re living in a democracy, are you buddy? It’s the free market. And you’re a part of it. You’ve got that killer instinct. Stick around pal, I’ve still got a lot to teach you. AND THE LAY AWAKE AT NIGHT TRYING TO FIGURE OUT HOW TO TAKE IT WITH THEM,RIGHT? NO MAN IS AN ISLAND

By my count, two bait and switches in the article, where the point is really about Medicaid in general but you make it seem its unique to the expansion, then a 3rd point I want to make.

1) You point out states are worried about long-term changes in the way the Federal gov’t pays for Medicaid. Their worry, which is not tied to any existing law, is based entirely on vague prognostications about the future of the federal budget. Of course, these kinds of worries are not tied to the Medicaid EXPANSION at all, are they? Similar things could happen to the existing Medicaid program. I understand that under the expansion, states would be responsible for MORE than they otherwise would be, but a Federal withdrawal from Medicaid would be a budgetary disaster whether or not states accept the expansion.

2) The woodwork effect is not directly tied to the Medicaid expansion. In fact, by definition it isn’t, as woodwork refers to people who are already eligible, and the expansion refers to the newly eligible. Publicity surrounding the law and the state-based exchanges will account for more of the woodwork effect than expansion. So again, this has little to with expansion. It’s just frustration with having to cover the uninsured. And that brings me to my last point.

3) As someone with ties to the Romney campaign, can you finally admit that you do not care much at all whether the poor in this country have health insurance? The Republican party once claimed that it did. But between Mitch McConnell’s recent statements, and articles like this one, it’s clear that your thinking has changed. After all, you just wrote an entire article about Medicaid expansion without noting it means 18 million more people will have health insurance. I understand this post was about state policy choices and the economic impact, and not health care per se, but dear god man, doesn’t it at least deserve a mention?

Budgets are not about having a piece of paper and tallying numbers on them. They’re about choices we make as a society. The Democrats have made a commitment to insuring everyone, and backed up that commitment with spending cuts, tax increases on health care providers and the wealthy, and closing loopholes to pay for that expansion. If you don’t want to take steps to make sure all Americans have health insurance, that’s fine, it’s simply a moral and ideological choice, but it’s important to be clear, and define exactly why your party changed its mind.